CWS Market Review – January 11, 2013

“The key to making money in stocks is not to get scared out of them.” – Peter Lynch

I’ll sum up this market up in four words: Fear is melting away. Wall Street continues to rally as the fear that gripped the market so intensely slowly fades away. This has been great news for the broader market—and especially for our new Buy List.

On Thursday, the S&P 500 closed at its highest level in more than five years. What’s even more impressive is that the Volatility Index ($VIX), also known as the Fear Index, recently dropped to its lowest level in five-and-a-half years. After seven days of trading, our Buy List is already up 4.34% for the year, which is 1.12% ahead of the S&P 500.

Earnings season is about to start, and we’ve had a flurry of good news this week. Both Stryker ($SYK) and Medtronic ($MDT) raised the low end of their full-year guidance. DirecTV ($DTV) rallied after the company said it had added 100,000 new subscribers in Q4.

How about Nicholas Financial ($NICK)? The little powerhouse came close to breaking through $14 per share. On Thursday, Oracle ($ORCL), Fiserv ($FISV) and Stryker ($SYK) all made fresh 52-week highs. (Is it me, or didn’t Oracle just break $30 a few weeks ago—and it’s already closing on $35?)

Perhaps the best news of all came from Ford ($F). The automaker said it’s doubling its dividend. In the CWS Market Review from a month ago, I said it is possible Ford could sweeten its dividend, but honestly, I was expecting something minor. Not doubling! This is an excellent sign of confidence from Ford. The stock got as high as $13.94 on Thursday, which is an 18-month high.

The End of the Fear Trade

Before we get too carried away, I want to warn you that this is a tricky market. Last week, I mentioned that we’re witnessing a “high-beta rally,” which means that a lot of bad stuff is getting pulled along with the good stuff. Fortunately, we have the good stuff.

What’s interesting is that the most-hated stocks on Wall Street, meaning those that are “shorted” the most, have been doing the best. The folks who have been short this market have been getting squeezed. This means they have to cover their shorts, and that’s propelling those hated stocks even higher.

I’ll explain what’s going on with a simple example. Let’s say you have two stocks that are perfectly equal in every way. Same industry, same finances, same logos, you name it, they’re exactly alike. Both are expected to earn $1 per share this year. However, there’s one difference. Stock A is expected to earn $1 per share, plus or minus two cents per share, while Stock B is expect to earn $1 per share, plus or minus 30 cents per share.

So which stock is going to be worth more? The answer is that in most cases Stock A will be worth more. It’s not entirely logical, but investors are more scared of the downside than they are optimistic for the upside.

But here’s the important part investors need to understand: While Stock A will usually be worth more than Stock B, that gap will fluctuate a lot. Sometimes, the crowd turns fearful and the A/B gap will open wide. But other times, when folks are more confident, that gap will narrow. The A/B gap will move according to the crowd’s fear level.

Now let’s bring our thought exercise back to the real world. What happened over the past few years is that the whole world got terrified. The A/B gap opened to ridiculous levels. Any investment that wasn’t a surefire guarantee got dumped. It wasn’t just stocks: we saw it in bonds as well. High-grade corporates lagged Treasuries, and junk bonds lagged high-grades.

As the fear is slinking away, the fear gap is closing up. As a result, the Stock Bs of the world are outperforming the Stock As. Meaning that anything that’s seen as carrying higher risk has been doing well. In the real world, we can see that in the fact that small-cap indexes like the Russell 2000 ($RUT) and S&P Small-Cap 600 (^SML) have recently hit all-time highs, even though the S&P 500 still has a way to go to match its all-time high. Even the Mid-Cap 400 (^MID) is at a new high. Last week, I showed you how well the High-Beta ETF ($SPHB) has performed.

This chart shows you that since mid-November, small-caps have done the best, followed by the mids, followed by large. Performance has been perfectly ordered by size (or risk, B to A).

Let me caution investors not to be too impressed by some of the stocks that they’ll see rally. Facebook ($FB), for example, is back over $30. FB is horribly overpriced, and there are lots of stocks rallying that are even worse. Don’t chase them. Instead, investors should stick with high-quality stocks like the names you’ll find on our Buy List. Now let’s look at some of the recent good news from our stocks.

Stryker and Medtronic Raise Guidance

Even though earnings season hasn’t begun yet for our Buy List, two of our stocks got ahead of the game by raising their full-year guidance forecasts. I should add that I like stocks that provide full-year forecasts. Companies aren’t required to do this, so it’s nice to see firms give more information to the public.

On Monday, Medtronic ($MDT) raised its full-year forecast to a range of $3.66 to $3.70 per share. That’s an increase of four cents per share to the low end. Medtronic has stuck by its original forecast since May, which is commendable. The increase is due to a research tax credit.

Note that Medtronic’s fiscal year ends in April, so Q3 earnings are due in about six weeks. For the first six months of this fiscal year, Medtronic earned $1.73 per share. That means we can expect $1.93 to $1.97 for the back end. Medtronic earned $3.46 per share last year. Medtronic remains a good buy up to $44 per share.

On Wednesday, Stryker ($SYK) raised the low end of their full-year guidance by one penny per share. The company now sees full-year earnings ranging between $4.05 and $4.07 per share. Stryker also said that sales for Q4 rose by 5.5%, while the Street had been expecting an increase of 2%. For 2013, Stryker reiterated its full-year forecast for earnings of $4.25 to $4.40 per share. Wall Street is expecting $4.30 per share. Earnings are due out on January 22nd. The shares closed Thursday at $58.84, which is a new 52-week high. I’m raising my Buy-Below on Stryker to $62.

Ford Doubles Dividend

After the South Sea Bubble went ka-blamo in the early 18th century, Sir Isaac Newton famously said, “I can predict the movement of heavenly bodies, but not the madness of crowds.” Ike, my man, I feel you.

Long-term readers of CWS Market Review know how much I like Ford ($F). When the stock dropped below $9 last summer, I thought either Wall Street or I had lost our marbles. Possibly both.

The numbers said Ford was cheap, and we stuck to our guns. Today, suddenly Ford is one of the hottest stocks on Wall Street. The stock got another big boost this week when the automaker said that it’s doubling its quarterly dividend from five cents to ten cents per share. The dividend hasn’t been this high in seven years. Going by Thursday’s close, Ford yields 2.89%. The stock jumped to an 18-month high. I rate Ford an excellent buy up to $15.

JPMorgan Chase ($JPM) is due to report earnings next Wednesday, January 16th. The Street currently expects earnings of $1.20 per share. My numbers say that’s too low. For now, I’ll raise my Buy Below to $47 per share, which is just above the current price. Let’s see how the earnings shake out before we make a larger move.

That’s all for now. Earnings season starts to heat up next week. Remember JPM reports on Wednesday. We’ll also get important reports on inflation and industrial production. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.